Convertible preferred stock is a type of equity security that combines preferred and common stock features. It allows holders to convert their preferred shares into a predetermined number of common shares, usually at a specific price. This type of stock provides investors with the benefits of preferred stock, such as dividend payments and priority in the event of liquidation, while offering the potential for capital appreciation through the conversion feature.
Which of the following is a characteristic of convertible preferred stock?
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A) Non-convertible preferred stock cannot be converted into common stock. B) Convertible preferred stock pays a fixed dividend. C) Cumulative preferred stock accumulates unpaid dividends. D) Adjustable-rate preferred stock adjusts dividends based on a benchmark interest rate.
What is the primary benefit of owning convertible preferred stock?
A) Capital appreciation is not guaranteed for any type of stock. B) Liquidation preference is a feature of preferred stock, not specific to convertible preferred stock. C) Participating preferred stock allows for participation in additional dividends. D) Convertible preferred stock offers the potential for capital appreciation through conversion into common stock.
What is the conversion value of convertible preferred stock?
A) The conversion premium is the difference between the market price of the common stock and the conversion price. B) The conversion value is the value of the common stock that the preferred shares can be converted into. C) The conversion ratio is the number of common shares an investor receives upon converting their preferred shares. D) The conversion price is the price at which the preferred shares can be converted into common stock.
In the late 1990s, a large technology company issued convertible preferred stock to raise capital for expansion. The stock paid a fixed dividend, allowing investors to convert their shares into common stock at a predetermined price. As the company's stock price soared during the tech boom, many investors converted their preferred shares into common stock, realizing significant capital gains.
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Example Series 65 Example Practice Question
A small biotechnology company issues convertible preferred stock to raise funds for research and development. The stock pays a 5% dividend and can be converted into common stock at a conversion price of $20 per share. If the company's common stock price rises above $20, investors may convert their preferred shares into common stock to participate in the potential capital appreciation.
Convertible preferred, a stock that's quite rare, with dividends fixed and a chance to share, in the common stock's rise, a choice to compare, for investors who seek both income and flair.
- *Conversion Ratio*: The number of common shares an investor receives for each convertible preferred share upon conversion. - *Conversion Price*: The price at which the convertible preferred shares can be converted into common shares. - *Conversion Premium*: The difference between the current market price of the common stock and the conversion price. - *Contingent Conversion*: A provision that allows the issuer to force conversion of convertible preferred shares into common shares under certain conditions. - *Conversion Value*: The value of the convertible preferred shares if they were converted into common shares at the current market price.
- *Conversion Ratio example*: If a convertible preferred stock has a conversion ratio of 5, the investor can convert each preferred share into 5 common shares. - *Conversion Price example*: If the conversion price is $20, the investor can convert each convertible preferred share into common shares for $20 per share. - *Conversion Premium example*: If the current market price of the common stock is $25 and the conversion price is $20, the conversion premium is $5. - *Contingent Conversion example*: A company may have a contingent conversion provision that allows them to force conversion if the common stock price reaches a certain level, such as 130% of the conversion price. - *Conversion Value example*: If the conversion ratio is 5 and the current market price of the common stock is $25, the conversion value is $125 (5 x $25).